2023-11-21 15:00:54 ET
Summary
- Twilio's Q3 earnings generated some new positive price momentum.
- The company's customer base is expanding, but revenue growth is slowing down dangerously.
- Twilio is also seeing weakness in customer monetization which I see as a headwind to a higher valuation.
- Considering a material increase in the firm's operating income guidance, I am rating Twilio as a hold.
Shares of Twilio ( TWLO ) have essentially been range-bound in 2023, but the company’s third-quarter earnings card has generated some new momentum for the communications platforms. Twilio raised its guidance for full-year operating income by a material percentage, but I am more cautious on the ticker due to slowing top line growth which fell into the single-digits in the third-quarter. Although Twilio’s customer base is expanding, customer monetization is weakening, raising a potential flag with regard to organic revenue growth prospects going forward. Given the rather significant growth slowdown, post-pandemic, I am changing my rating from buy to hold!
Previous rating
I worked on Twilio more than a year ago, in the third-quarter of FY 2022, which is when I evaluated TWLO as a speculative buy due to double-digit top line growth as well as a high Dollar-Based Net Expansion Rates in excess of 130%. Given that the company has lost revenue momentum and top line growth slowed down by half from Q2'23 to Q3'23, and monetization is reaching a concerning key point, I believe a hold rating is justified.
Post-pandemic revenue trajectory
Twilio experienced profound revenue tailwinds during the pandemic which boosted remote working and drove adoption of cloud-based communication platforms like the one provided by Twilio. Twilio offers tools that allow companies to communicate effortlessly with their customers through various channels, including email, messaging and voice.
Strong product adoption has been a key growth driver for Twilio during the pandemic, but the end of COVID-19 also meant the end of super-charged top line growth rates. In the third-quarter reported on November 8th, Twilio grew its revenue base only 5% year over year, which was half the growth rate in the second-quarter and marked a massive 28 PP decline compared to the year-earlier period. As of right now, it appears that Twilio's quarterly revenues have plateaued at slightly above $1.0B.
My key issue with Twilio: customer monetization weakness
Although Twilio's customer accounts are still growing -- Twilio had more than 306k active customer accounts in Q3'23 compared to 304k in Q2'23 -- the monetization trend is something that I am worried about. Software companies tend to measure their monetization success through a figure called Dollar-Based Net Expansion Rate/DBNER. This figure measures organic revenue growth from one period to the next and therefore expresses a company's success in retaining and upselling its customers.
A DBNER figure of 120%, as an example, shows that customers are increasing spending on a software platform by 20% Y/Y. The closer the DBNER figure edges towards 100%, therefore, the weaker a company's organic revenue outlook. In Twilio's case, the DBNER figure has gradually contracted, revealing a weakness in monetization, in my opinion. In the third-quarter, the firm's Dollar-Based Net Expansion Rate dropped to just 101% and it has fallen consistently every quarter in the last year. When I last worked on Twilio, the company had a DBNER figure consistently above 120%.
Raised guidance
One positive take-away from Twilio's third-quarter earnings release was that the company materially raised its forecast for non-GAAP income from operations, from a range of $350-400M up to $475-485M, which reflects a significant raise of $105M at the midpoint (+28%).
Twilio’s valuation and upside revaluation potential
Twilio is not growing as fast as I expected which is the reason why I am down-grading the company's shares to hold. Twilio is expected to generate revenues of $4.45B in FY 2024, meaning the company will continue to hover around $1.0-1.1B in quarterly revenues and is unlikely to return to the revenue momentum experienced during the pandemic.
In total, analysts project an average annual top line growth rate of 10% between FY 2023 and FY 2027, based on Seeking Alpha-provided consensus estimates. Based off of revenues, Twilio is valued at 2.6X revenues which is not a particularly high revenue multiplier factor compared to other businesses operating in the cloud space. Salesforce ( CRM ), Fastly ( FSLY ) and DocuSign ( DOCU ), which run cloud-based business models to streamline business processes, trade at P/S ratios of at least 3.0X... and I consider none of them really cheap since most of them have suffered similar top line post-pandemic slowdowns as Twilio.
What makes things a bit worse here for Twilio is that the company, besides a revenue slowdown, has issues with the company's monetization. A 2.6X revenue multiplier would be appropriate, in my opinion, if Twilio returned to double-digit top line growth and generated a Dollar-Based Net Retention Rate of ~120%, in my opinion.
Risks with Twilio
As a communications platform, Twilio depends on a strong enterprise market and corporate willingness to spend money on new products and services. The ability to monetize its customers and grow platform revenues organically is therefore key to Twilio’s financial success in the long term. Therefore, monetization, as expressed by the Dollar-Based Net Expansion rate, should be the key focus for investors going forward. The DBNER figure is close to falling below 100%, the level required to sustain the current revenue base. A drop below this level combined with a soft revenue growth outlook could hurt Twilio's valuation again.
Final thoughts
Twilio is seeing a rather dramatic slowdown in post-pandemic revenue growth and although the API-based communications platforms is seeing an expansion in its enterprise customer base, monetization, which I would argue is even more important than mere revenue growth, continued on its down-trend in Q3'23. Twilio's DBNER is at risk of falling below 100% which would likely be a negative stock catalyst. Twilio did raise its operating income guidance by a material amount, however, which was definitely a positive take-away from the third-quarter earnings report. Overall, however, I don't believe the risk profile is especially attractive at this point given that Twilio's growth has slowed down so much and that the company, at least so far, has not found a way to reverse its customer monetization trend!
For further details see:
Twilio Has A Growth Problem (Rating Downgrade)